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Citigroup, AIG Dampen Wall Street's Optimism

Citigroup announced on Friday that it was selling off $400 billion of its assets in an attempt to restructure itself to move beyond the financial crisis in the credit and mortgage markets that have affected many financial services firms.

Despite some optimism on Wall Street that things are improving, the downturn continues to take a toll on companies. On Thursday, insurance giant American International Group announced a huge loss — $8 billion — related to bad mortgage debt.

Citigroup Inc. has become a financial behemoth with all sorts of divisions and businesses. It has assets that exceed $2 trillion.

"They have become large and inefficient and in a crisis that catches up with you in a way that it doesn't in good times," says Peter Morici, an economist and professor at the University of Maryland. "What has become apparent is that these large companies like Citigroup cannot manage risk effectively when they are so diverse, because they don't know what the various units are doing."

Citigroup CEO Vikram Pandit acknowledged the company had problems in its securities and banking divisions: "The volatility in this business and the overall returns have been unacceptable, and it's clear to me we need to restructure our model. That said, I would also add that the entire industry in this area is transforming and searching for the future."

Regrouping for the Future

Brian Bethune, an economist with Global Insight, says one encouraging sign is that sovereign wealth funds — investment funds run by foreign nations — as well as other investors, have been willing to step in and help.

"The recapitalization efforts have been quite successful," he says. When investors provide money to companies enabling them to move beyond these crises, it acts as a buffer — lessening the overall shock to the financial system, he explains.

Until very recently, things were really a mess in the mortgage system and broader credit markets. Bear Stearns was imploding and companies were afraid to do business with each other.

"This thing was just continuing to deteriorate. It was a viscous cycle spiraling downward and there was a lot of despair. There was no way to stop it," says Bethune.

He says the record numbers of bad loans and foreclosures had the debt markets all fouled up because many firms refused to even buy assets backed by good loans with low risk. If homebuyers and big companies can't borrow the money they need that's bad for the whole economy.

Fed Intervention

Then in March, the Federal Reserve Board stepped in and propped up struggling investment banks that were at the center of this storm by promising to loan them money. That did a lot to dispel the real panic on Wall Street.

"That, in some respects, represents a watershed because there's a sense that there's light at the end of the tunnel," says Bethune.

He says the logjam is showing signs of breaking up. Lower-risk mortgage securities are starting to trade in more rational ways. Some banks have even been selling some of the riskier stuff to get it off their books.

But economists say the housing market isn't showing any signs of getting better. And even more foreclosures could result as home prices fall. Big companies will suffer more losses, and more small and regional banks are likely to fail.

"My feeling is we don't know how deep the hole is right now," says Morici. Some industries are still doing pretty well. But many economists think all this will mean, at best, a mild recession followed by very sluggish growth that drags on for at least a couple of years. Meanwhile, foreclosures are at their highest rates in 50 years and rising.